Question
Anderson Aeronautics currently has a capital structure made entirely of equity with total invested capital of $ 14 million. They are considering issuing new debt
Anderson Aeronautics currently has a capital structure made entirely of equity with total invested capital of $ 14 million. They are considering issuing new debt to replace some of this equity. Anderson currently has a beta of .8, and is considering replacing either $4 million in equity or $8 million in equity with new debt. Andersons current corporate tax rate is 25%. The interest rate (rd) on $4 million of debt is 12%. The interest rate (rd) on $8 million in debt is 18%. The risk-free rate is 3% and the return on the market is 16%. Anderson has an EBIT of $2,250,000.
a. What will be Andersonss new levered beta if it replaces $4 million in equity with debt?
b. What will be Andersons new levered beta if it replaces $8 million in equity with debt?
c. What will be Andersons weighted average cost of capital (WACC) if it utilizes no debt, $4 million, and $8 million in debt?
d. What is Andersons ROE under the 3 different scenarios (no debt, $4 million debt, $8 million debt)?
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